Why low-volatility strategies make sense right now

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Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

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Leslie Alba, head of portfolio solutions, Total Investment Solutions, CIBC Asset Management 

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There are several benefits to holding low-volatility equity strategies in the current environment. Looking past many news headlines, we don’t rule out the possibility that trade tariffs are not merely threats, but are actually, really tools to support Trump’s America First policy. And so we believe we’re potentially facing a paradigm shift.  

We think of it as, you know, possibly the end of Pax Americana, where U.S.’s manufacturing industry restores its competitiveness, and where the rest of the world bears their share of defense spending. 

Looking closer to home, you know, the trade war between America and Canada appears to be escalating, and yet this hasn’t translated into extreme volatility in equity markets. We’ve seen recent weakness, but we think it could get worse from here.  

So with continued uncertainty around tariffs and what that would mean for businesses, consumers and, ultimately, economic growth, we believe it’s prudent to prepare for a period of heightened volatility for the foreseeable future.  

And so the benefit of low-volatility equity strategies is that, and it’s really in the name, low-volatility strategies are expected to help mitigate the impact of market swings on investor portfolios.  

One thing that’s important to remember, though, is that it almost always seems like there’s a reason to sell out of the market, and yet the market almost always climbs over that wall of worry, and we find ourselves on the other side. 

If we reflect on the recent past, you know heading into 2024, recession fears really dominated market narratives. There was a concern that central banks around the globe were too aggressive with their tightening policies, and that, coupled with inflation, that would put strain on the consumer and push many global economies into a recession. And yet 2024 equity market returns were exceptional. In Canadian dollar terms, for 2024, the TSX composite index was up 21.6% the S&P 500 up 36.4%, MSCI EAFE up 13.8%, and MSCI Emerging Markets up 17.9%.  

And then when we look further back into the recent past, the 2023 wall of worry included extreme valuations within U.S. equity markets that was pretty reminiscent of the dot-com bubble. And then in 2022, there were fears about high and sticky inflation, you know, transitory or not, and rising interest rates. And as daunting as all of those concerns were, markets nevertheless tended to continue to eventually reach new peaks.  

And so despite our view around heightened volatility over the near term, we remain positive on equities over the long term. So investing in a low-volatility equity strategy is a great way to keep equity exposure, which we believe is important because, in our view, equities will continue to be a cornerstone for wealth generation over the long term.  

Low-volatility equity strategies help investors maintain exposure to long-term capital appreciation, but through strategies that have the potential to smooth out investor returns over that time period.  

Combining low volatility with dividend strategies could be a winning strategy for certain investors, such as those perhaps with a lower risk tolerance than what might be experienced through growth stocks or the current market-cap weighted market exposures, or for investors with income needs.  

By targeting securities that pay dividends, these strategies are expected to provide a steady stream of regular income that has the potential to grow. And this is especially useful as interest rates decline.  

When interest rates moved up rapidly in 2022, investors looking for yield may have invested in short-term assets, such as GICs or guaranteed investment securities, as well as high-interest savings accounts. But with lower policy rates in Canada now relative to the peak we reached in 2023, several Canadian investors might be looking for alternatives to those short-term assets.  

Dividend strategies are an attractive way to put this money back to work while generating income. Currently, there’s over $200 billion in excess savings in GICs and high-interest savings accounts.  

As these short-term investments come due or reflect lower interest rates, the income-seeking investors can look to reallocate to dividend-paying securities to achieve those income needs. And dividend securities not only generate income, but also provide the opportunity to participate in the upside of a market, while protecting on the downside.  

Generally, investing in dividends can be considered a reasonably defensive strategy compared to investing in growth stocks, which, despite many of them retracting over the recent weeks, those growth stocks continue to flaunt high valuations relative to other parts of the market.  

As we experience, stock prices can fluctuate, but dividend payments are relatively consistent. So not only do they offer a bit of a returns buffer, they also provide some predictability to expected returns on dividend paying stocks.  

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So ETFs, or exchange traded funds, can be an attractive way to support this type of opportunity for investors. Interest in ETFs has exploded in popularity recently, in terms of both number of products and assets under management. What they do is they help diversify your investment, because rather than tying all your investment money into a single security, ETFs provide investors access to a professionally managed pool of securities where they would be less exposed to market volatility or individual security risk.  

Another key benefit of an ETF is that it can be bought and sold on the stock exchange through a brokerage account. And because they’re on the stock exchange, they tend to be more flexible than traditional mutual funds, as they can be traded when the markets open. And then in general, ETFs do tend to have lower fees than mutual funds.  

So these strategies are a really valuable tool for advisors to discuss with clients because it can help provide comfort, especially in times like these, where economic uncertainty looms large and emotions can run really high.  

While the source might differ, volatility is a key feature of markets, and while we should be used to the ebbing and flowing of volatility, in the face of it, it can be scary. But our advice is to stay diversified across a broad range of assets, while diversified portfolios can eliminate much of the volatility coming from idiosyncratic risk or risk that’s associated with a single investment.  

But that said, non-diversifiable risks remain, and that really is the general risk of markets. So including low-volatility and/or dividend strategies in investor portfolios can help diversify risk and generate a smoother return stream over time. Low-volatility or dividend-paying companies tend to have low correlations to other parts of the market, such as high-growth tech companies that continue to dominate important global equity markets.  

Also, these lower volatility or dividend-paying companies can provide some downside protection. When markets correct, low-volatility and high-dividend companies with good, strong free cash flows and stable balance sheets tend to outperform the market in those periods.  

That said, we do need to avoid the point where short-term considerations impact long-term investment goals, and most people’s investment or financial goals do tend to be long term in nature. So really, the key here is to stay diversified and to remain invested.  

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In this environment of elevated economic uncertainty and the current threat of a trade war, low-volatility and dividend strategies have done relatively well. Year-to-date, to the end of March 20^th, low-volatility, high dividend stocks in sectors like utilities, telecoms and consumer staples have outperformed lower dividend stocks in growthy sectors like those in technology and consumer discretionary.  

Because low-volatility, dividend-paying stocks tend to provide some level of smoother returns and some downside protection, we expect these types of strategies, low-volatility dividend strategies, to continue to do well in an environment of high uncertainty and high volatility.

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